When Is a Development Agent or Similar Third Party a Franchisor?

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The typical franchise system structure involves two levels and two parties: the franchisor that sells the franchise and the franchisee that purchases it. Trends over the past few years suggest, however, that franchisors are increasingly structuring franchise systems into three levels. The addition of a third tier to the franchise relationship creates unique legal issues for a franchise attorney because the duties, rights, and liabilities of the third party are not always apparent. This article will analyze federal and state statutes, rules, regulations, and agency opinions to determine how third parties, particularly development agents, are treated under federal and state franchise law.

This article first outlines the three basic forms of a threelevel franchise structure and then summarizes the characteristics of each form. A three-level franchise structure contemplates the contractual involvement of a third party with the franchisor, or both the franchisor and the franchisee, for the purpose of undertaking certain functions typically reserved for the franchisor. Although franchisors have continued to create new titles and functions for third parties to a three-level franchise system, these third parties can generally be divided into three categories: master franchisees; area (or regional) developers; and development agents, also referred to, often interchangeably, as area representatives or regional representatives.1 For simplicity’s sake, this article will refer collectively to the third category as development agents. After discussing these categories, this article analyzes the Federal Trade Commission’s Amended Franchise Rule (FTC Rule)2 and state guidelines to determine how each third party is defined and treated by the FTC and various state regulators. Because of the enormous variation in laws, this article focuses on examining how states treat third parties to determine if and when a third party is a subfranchisor subject to federal and state disclosure and registration requirements.